Would like to bring a discussion over here.
When it comes to analyzing and comparing companies within the same industry, such as Consumer Goods, what is the relation between Gross Margin / EBITDA Margin and EBITDA multiple valuation?
If you have a company with higher gross margins (higher aggregate value of the product / premium product vs. mainstream), and considering a similar G&A structure, that would imply a higher EBITDA margin as well. What will be the impact on relative valuation of a premium segment company vs. a standard commodity product company? Can we apply a rule of thumb such as: premium product companies present a lower EV/EBITDA multiple because EBITDA is higher, etc.?
How about comparing companies from different industries? Is there a rule of thumb for determining this without specific knowledge of that industry and cost structure? I mean, "Quick question: sector A or B, which one will have a higher multiple?"
I am asking this because answers to this question have varied a lot.
Thanks guys.
In theory? Valuation is based on discounted cash flows and the multiple is implied from there. Free Cash Flow is another item to look at in addition to margins, some businesses within the same industry will have different capex programs and leverage profiles.
Using some extremes to look at cross-industry comparisons - I would expect an energy firm to trade at a significant EBITDA multiple discount to a software firm due to (a) heavy capex requirements and (b) long term cash flow growth concerns.
Yep, you are correct. I wonder about the Net Working Capital part of the rationale.. any input on this?
NWC is linked to the cash conversion cycle. Businesses with a high NWC requirement get their cash flows kicked out longer than others, so they would theoretically trade at a discount to peers that have a quicker CCC.
Interesting questions and I'll try to provide some insights from an M&A perspective below:
• In my experience, if you're looking at EBITDA based valuations, margins don't typically come into play. What you will see are normalized or adjusted EBITDA values to account for operational efficiency gains resulting from the buyer. For eCommerce companies, you may also need to adjust revenue and COGS to account for differences in how shipping is reported. If your client charges for shipping and the buyer doesn't intend to charge for shipping post-acquisition (since the trend is towards free shipping), you might have to back that revenue stream out. For COGS, the buyer may have a better shipping network and contracts in place which would result in an immediate cost synergy.
• If we're comparing apples to apples companies with one being a premium co and the other being a commodity co, the premium company will almost always have a higher EBITDA multiple. Premium product cos are premium because they have some kind of a moat (i.e., competitive advantage) established that allows them to capture higher prices and thus, more bottom line value. Typically, premium product markets aren't nearly as saturated as commoditized markets and don’t face the same downward pricing pressures.
• This one’s hard to answer without a lot of assumptions being made but the simplest way I would go about this is considering the potential moats related to specific industries. If you were to look at tech and consumer, I would consider the following:
o Consumer – unless you have some kind of patented formula/technology or some other aspect of your business that others can’t duplicate, your “brand” will ultimately be your worth. Most consumer cos generally fetch 1-2x revenue and 8-14x EBITDA.
o Tech - again, this largely depends on the moats established by the company but on average, you’ll find more at tech cos than consumer cos. A couple of other considerations would be (a) revenue model – is it licensed or recurring and how much revenue is generated from services or labor intensive work (less is better) and (b) is it consumer or enterprise focused or both (this relates to market potential and repeatability of revenue. Overhauling the tech in a company is a costly investment and is typically avoided, if possible.). Another consideration would be that tech companies typically take much longer to achieve profitability and are often valued off revenue or ARR (annual recurring revenue) rather than EBITDA. They also experience significant margin expansion with growth resulting in top line multiples being more consistent than bottom line multiples. In general, tech has higher multiples than consumer.
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